Sunday, May 15, 2016

What do Business Brokers and Business Sellers mean by 'Standard Multipliers?' -Viewer Question - David C Barnett

Hello
everyone, David again with another viewer question. This time I’m asked, ‘what are these standard
multipliers that business brokers and sellers talk about when pricing a
business?’ Watch my video answer to this
question here: https://youtu.be/ACyjxnhzpDk

Well here’s
the idea: if you multiply the earnings of a business by a number, you get a
value. If you use the right magic number
you find out the value of the business.

My
preferred method of doing this kind of thing is called the Direct Market Data Method.
When doing this you need to normalize the financial statements using a
proper set of rules. Then you research
the subject company and find what others have paid for similar sized businesses
in the same industry using databases created by valuation professionals. You then multiply the cash flow by the factor
you discover in your research and find what’s called an Enterprise Value.

You then
need to adjust this value based on operating capital that forms part of the
transaction.

As you can
see, this is not a simple thing for amateurs.
If the wrong data is researched you get a bad result, if the wrong
normalizations are done, you get a bad result, etc.

Let me give
you some examples. A small mom and pop
restaurant might be valued at 1.1 times SDE (Seller’s Discretionary Earnings)
while a septic pumping business with the same amount of cash flow could go for
3.6 times SDE. A larger restaurant with
100 employees may go for 2.8 times SDE.

As you can
see, if you try to apply a ‘standard multiplier’ to these businesses, you
either end up over or under valuing them.
The reason the multipliers change by industry and enterprise size is
because of the differing degree of risk.
What I love about this method is we actually get to apply the opinion of
past buyers as to the degree of risk they saw in their transactions.

In one
crazy case I was asked to review a business valuation which had been prepared
by an accountant. The guy had taken net
income, multiplied it by 4 because he thought this was the right ‘standard
multiplier’ and used the result as the value of the goodwill. Then he calculated the net operating capital
and added this. Then he estimated the
value of the fixed assets and added that too.

The result
was a million dollar valuation on a business that put $100,000/year into its
owner’s pocket including his salary.
This would be the type of value we might see on the stock market for a
publicly traded company and it obviously didn’t make any sense.

So, when
you hear someone defend an asking price on a business because of ‘standard
multipliers’ you should be very cautious.
It may mean that you’re talking to someone who doesn’t quite know what
they’re doing. They may be trying to use
jargon which they think is impressive to bully you into agreeing with what they’re
trying to sell.

Anyone who
is going to buy or sell a business should engage an experienced and qualified
person to value the business and understand fully how the final number was
arrived at. Also, there are some simple
ways to ‘test’ any figure that I share with my clients regularly.

Please
remember to like and share this article, it’s the only way the people who run
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who needs this information will be able to find it.

Also, I
have a new FREE tool for business owners.
15 questions to ask yourself daily to help maximize the value of your
business. Download it free here: https://gum.co/15Questions/FREE Remember, I DO NOT automatically add people
to any e-mail marketing lists without their permission.